Credit rating is the statistical system used by lenders to determine your creditworthiness. Before extending any loan or credit to you, lenders check things like how much money you earn, how long you’ve been using credit and whether you’ve made payments on time.
Information about you and your credit experiences is collected from your loan application and your credit report. Using a statistical program, lenders compare this information to the credit performance of consumers with similar profiles. A credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points – a credit score – helps predict how creditworthy you are, that is, how likely it is that you will repay a loan and make the payments when due.
Why is credit scores are used?
More credit. Better pricing. Objective assessment. These are just few of the benefits of your credit information report (CIR), reflecting debt obligations serviced regularly and in a timely fashion.
When you approach a lender for credit, your application will be evaluated on the basis of your past payment history, existing credit lines and other factors such as income and security. In this case, a good CIR is one of the best indicators of the level of risk you present to the credit grantor. A CIR that reflects a good past payment history may lead to credit being granted on better terms. On the other hand, a CIR, which indicates that a borrower has been delinquent on several occasions, could lead to denial of or extremely expensive credit.
Credit Rating in India
Credit Information Bureau (India) Limited (CIBIL) provides lenders information about your credit information report (CIR). For the first time in India, CIRs containing factual records, credit histories of borrowers are available. Lenders across the country access reports from CIBIL in order to make quick, objective credit decisions.
What can you do to improve your credit score?
Credit scoring models are complex and often vary among creditors and for different types of credit. If one factor changes, your score may change. The trick here is you can’t find out your score. Companies providing loans and credit do not disclose their credit appraisal criteria. But both the score and the statistics that go into it are top secret. The reason being that if people understood their appraisal criteria and scorings, they could cheat by altering their profile thereby artificially jacking-up their over all credit score.
But, of course, we will try to improve our credit scores, won’t we?
There are certain things we do know. Fewer credit cards are better than several cards. Paying on time is a must. Some of the things that weigh heavily are stability both at home and on the job and a good payment history. The scoring system looks at how close you are to the limits on your cards, what you spend money on and how much you ask for in cash advances.
In order to ensure a high-quality CIR, it is important to re-pay your loans on time. However, as you accrue more debt, special efforts are required to ensure this. The ‘buy now, pay later’ mindset has left borrowers struggling to strike an adequate cash-flow balance. In this scenario, it is extremely important for you to maintain appropriate, reasonable and affordable levels of credit and ensure regular and timely re-payment of loans.
Scoring models generally evaluate the following types of information in your credit report:
- What is your outstanding debt? Many scoring models evaluate the total amount of debt that you have compared to your credit limits. If the amount you owe is close to your credit limit, that is likely to have a negative effect on your score.
- Have you paid your dues on time? Payment history typically is a significant factor. It is likely that your score will be affected negatively if you have paid your dues late.
- How long is your credit history? Generally, lenders prefer a seasoned credit history i.e. a credit track record of more than a year. An insufficient credit history may have an effect on your score, but that can be offset by other factors, such as timely payments, low balances and previous relationship with the lender.
- How many and what types of credit accounts do you have?
Although it is generally good to have established credit accounts, too many loans and credit card accounts may have a negative effect on your score.
Scoring models may be based on more than just information in your application from and bank statements. For example, the lenders may investigate your credit reputation by contacting your employer, friends or neighbors. Lenders also look at your spending behavior. The model considers all these information for evaluation.
Ways to improve your credit ratings:
- Immediately establish a budget in order to control your cash outflows.
- Ensure that your income level permits an additional monthly outflow if you plan to take a loan.
- Investigate your options in order to reduce your interest and other credit related costs, e.g., refinance an outstanding loan at fixed interest rates if there is a significant drop in interest rates or you discover a significantly cheaper option, etc. This will make your debt burden easier to manage.
- Use some of your savings to repay some of your debt.
- Always pay on time.
Credit scoring systems enable lenders to evaluate a number of applicants consistently and impartially on many different characteristics. There are pros and cons to the credit scoring system. On the plus side, it eliminates discrimination because approval is based on raw numbers. Although you may think such a system is arbitrary or impersonal, it can help make decisions faster and more accurately. On the other hand, the scores don’t take into account consumers who have exceptional circumstances. Still, you must understand how it works if you’re going to get it to work for you.